The slowdown in the economy poses a political challenge to Germany’s chancellor, Gerhard Schröder

“THERE is no cause for panic,” Germany's normally unruffled chancellor, Gerhard Schröder, says grimly, implying that some think otherwise. Not since 1996 has the outlook for Europe's biggest economy been so gloomy. According to Ifo, a Munich-based research institute, Germany can expect growth of no more than 1.2% this year. There is even talk of recession. Unemployment has been rising relentlessly for the past five months. Inflation in May reached an annual rate of 3.5%, its highest since 1993. Industrial production is tumbling. Business confidence is at its lowest in two years. And a general election is due in just over a year.

Panic? Well, maybe not. But there is a whiff of something approaching it in government ranks. Only a few months ago, the Social Democrats seemed a shoo-in for a second four-year term. The economy was chugging along nicely, or so it seemed. The ruling red-Green coalition appeared united, with its most controversial reforms safely out of the way. The opposition, the strife-torn, scandal-rocked Christian Democrats, seemed a spent force. Mr Schröder could even dream of winning an absolute majority in the next election, something no party has achieved since 1957.

But the latest crop of grim economic data is beginning to damage the smooth-talking chancellor. As recently as April he was still talking of being on a path of “robust growth”, before agreeing to trim the government's forecast for the current year from 2.7% to 2.0%. Now, just two months later, it looks as if it may have to be revised sharply downwards again.

All the more dangerous for Mr Schröder, then, if Edmund Stoiber, the powerful premier of Bavaria and the leader of the Christian Democrats' sister party in that state, the Christian Social Union, were to decide to stand against Mr Schröder in next year's election. Bavaria, once one of (West) Germany's poorest and most sluggish Länder (states), is now one of its richest, most modern and prosperous. The lean, silver-haired Mr Stoiber radiates competence, authority, control.

Angela Merkel, the Christian Democrats' leader, appears in contrast to be almost a country bumpkin, woefully lacking the qualities needed to govern the country in troubled times. Even within her own party, more and more voices can be heard suggesting that the Bavarian premier would be the best person to take on Mr Schröder. According to the latest opinion polls, 56% of centre-right voters would like to see Mr Stoiber as their candidate for chancellor; a mere 16% opted for Mrs Merkel, leader of much the bigger party.

But Mr Stoiber has repeatedly said he will not stand, preferring to remain premier in Bavaria. What he wants, of course, is not necessarily the same as what he will do—given enough pressure. But his persistent denials are leading some to think that he really does mean what he says. Mr Stoiber is nearly 60. In Germany's second-most populous state, where his party has held an absolute majority of the legislature's seats for the past 30 years, he can do pretty well what he likes. His wife of the past 33 years, to whom he is devoted, does not want to move.

Besides, there is still little evidence that he would win. Despite the darkening economic landscape, Mr Schröder remains well ahead in the opinion polls. Asked which party could best solve Germany's problems, nearly a third of respondents still plump for the Social Democrats, twice as many as choose the Christian Democrats; half consider no party competent. But, as Mr Schröder knows only too well, the public mood can change fast. And the danger signals are already there.

The Christian Democrats are now pressing the government to try to boost the flagging economy by bringing forward the income-tax cuts due to be phased in over the next four years and dropping its next planned rise in energy taxes. But the government is resisting. It has staked its reputation on its ability to control public spending and reduce new borrowing to nil by 2006. DM45 billion ($19.8 billion) has already been lopped off company and private-household tax bills this year. It is still hoping the cut will help pep up domestic demand, though there is little sign of that yet. With tax income weak because of reduced growth, and with mounting costs from rising unemployment and “mad-cow” disease, the government is now unlikely to meet this year's planned public-spending deficit of 1.5% of GDP.

On the economic front, Mr Schröder has little room for manoeuvre. He could try to tackle some of the infamous rigidities in Germany's labour market—but not with a general election looming. Indeed, in some respects the rigidities may be worsening. Last week several regional health-insurance funds said they would put up premiums. That will scupper the government's pledge to bring health and other social-welfare contributions below the equivalent of 40% of gross wages. A law strengthening company works councils, passed last week as a sop to the unions, will not help either.

But Mr Schröder should not be underestimated as a tactician. He already has a solid set of reforms behind him, and just last weekend, after years of wrangling, two more were approved: a new revenue-sharing scheme among the Länder to run from 2005 until 2020, and a new DM306 billion “solidarity pact” for the former communist eastern states. Moreover, despite the election, he is forging ahead with further controversial legislation: an immigration bill and a reform of civil-service pensions promised for this autumn.

Few economists believe there is a serious danger of recession in Germany, in the sense of negative growth over at least two quarters. Most guess that the economy will begin to pick up in the second half of the year, after a poor second quarter. But no one doubts that from now on the going will be a lot rougher for Mr Schröder.